Types of Bankruptcies Explained: Which (If Any) Fits You?

Types of bankruptcy

Do you have severe debt problems? Are you underwater with credit card debt, have a mortgage you can’t manage, unpaid medical bills, outstanding personal loans, and other unsecured debt, or have your wages garnished?

According to statistics from the Administrative Office of the U.S. Courts, the September 2021 annual bankruptcy filings totaled $434,540. Filing for bankruptcy may hold the key to your debt relief.

Here are some bankruptcy basics:

There Are Six Types of Bankruptcy

According to U.S. Bankruptcy Code, there are six different types of bankruptcy. Each is named after the chapter in the code that describes it.

  • Chapter 7 (personal)
  • Chapter 13 (personal)
  • Chapter 11 (most commonly used for businesses)
  • Chapter 12 (for family farms and commercial fishing operations)
  • Chapter 9 (for cities and municipalities)
  • Chapter 15 (for foreign nationals)

All bankruptcy cases are handled in federal courts under rules outlined in the U.S. Bankruptcy Code, but there are many different types, with different costs and criteria.

Which will work for you? Here is a breakdown of the six options.

Personal Bankruptcies: Chapter 7 and Chapter 13

There are two primary options for personal bankruptcy: Chapter 7 and Chapter 13. Chapter 7 is the most common type of bankruptcy, but several key differences exist between Chapter 7 and Chapter 13.

  • Chapter 7 erases most personal debts, but has strict income limits, so not everyone will qualify.
  • Chapter 13 establishes a repayment plan. You will make monthly payments to your bankruptcy trustee, who will, in turn, pay your creditors. Chapter 13 offers protection against liquidation, and protects the filer’s home from foreclosure.

READ MORE: Chapter 7 vs. Chapter 13 bankruptcy

Business Bankruptcies: Chapter 7, Chapter 11 & Chapter 12

Most new small businesses don’t survive and are faced with deciding whether they should file for some form of business bankruptcy. Between 2005 and 2017, only about one-fifth of new small businesses lasted more than one year.

There are three types of bankruptcy filing options for business owners who aren’t sole proprietors: Chapter 7, Chapter 11, and Chapter 12.

Chapter 7

The Chapter 7 process for an individual versus a business is similar, but there are significant differences. Chapter 7 may be the best choice when no viable future exists. It is called liquidation since its debts are overwhelming, and restructuring is not an option.

When a business files for Chapter 7, it stops all operations and goes completely out of business. Chapter 7 is appropriate when the company doesn’t have any substantial assets.

Chapter 11

Chapter 11 is a reorganization of a business with a plan to pay off its debt. It is a simplified definition, but in reality, it takes years of legal proceedings between the person filing, the trustee and creditors. It is the most complex form of bankruptcy and the most expensive. It is most expensive and typically used by businesses, but nearly anyone can file for this type of bankruptcy.

Under this filing, businesses remain open while they implement a reorganization plan.

According to the U.S. Courts website, some required documents for a Chapter 11 filing are:

  • A list of all company assets and liabilities.
  • A statement of all financial affairs (to include marriage status, previous bankruptcies, property purchases or sold, gifts, bank and money market balances, etc.) A list of all income and expenses.
  • A list of all executable contracts and unexpired leases.
What are my bankruptcy options if I have a small business?

Small businesses’ primary types of bankruptcies are Chapter 7, Chapter 11, and Chapter 13.

Which type of bankruptcy you choose to pursue will mostly depend on how your business is structured, its assets, and plans for the future. For example, Chapter 13 can be a good option if you’re a sole proprietor. For Chapter 11, a small business with sufficient cash flow can remain open and make smaller payments to its creditors. In Chapter 7, a company with no cash flow can close efficiently and liquidate. Always consult an experienced small business bankruptcy attorney to learn which option is best for you.

Pro tip: If you are a service-only business like a writer, swim coach, accountant, handyman, and the likes, Chapter 7 is the best option since the trustee cannot sell your future services. Most states exempt the equipment needed in your profession, and sometimes the Trustee will let you continue to work during the bankruptcy if you have liability insurance.

Chapter 12

Chapter 12 bankruptcy is a reorganization for family farms and fishing businesses with a regular annual income.

Like Chapter 13 Bankruptcy, Chapter 12 filings allow these businesses to propose a monthly payment plan to their creditors over a 3-to-5-year period to eliminate debt. The repayment term will depend on a few factors, such as the debtor’s income and any remaining debt, such as alimony and child support.

The U.S. Courts website states that to qualify for a Chapter 12 filing, and the prospective filer must:

  • Have a farming or fishing business.
  • All debts from the company must not exceed $4,153,150 (for a farming business) or $1,924,550 (for a fishing business).
  • For a family farmer, at least 50%, and for a family fisherman, at least 80% of the total debts (not including the home) must be related to the farming or commercial fishing operation.
  • More than 50% of the filer’s gross income for the preceding tax year must have come from the farming or commercial fishing operation.

If a potential filer is a farm or fishing business that is a partnership or corporation, there may be additional criteria that need to be met to seek a Chapter 12 bankruptcy.

Other Types of Bankruptcy: Chapter 9 & Chapter 15

The general goal of bankruptcy is to clear debt, but not all bankruptcies are created equal. There are six types of bankruptcies. Chapter 7, Chapter 11, and Chapter 13 are the most common. As an individual, you will be dealing exclusively with Chapters 7 and 13. There are two more types that apply for cities and foreign nationals.

Chapter 9

Chapter 9 bankruptcy is intended for municipalities to restructure their debt, including cities, towns, counties, and school districts. This type of bankruptcy can damage a community’s reputation and be heavily laden with paperwork.

While Chapter 9 bankruptcy works similarly to the other types of bankruptcies described, the significant difference with a Chapter 9 filing is that the state cannot liquidate a municipality’s assets to settle a debt. Such a move would be a violation of the Tenth Amendment.

Detroit’s Chapter 9 filing in 2013 is probably the most well-known example.

As with all bankruptcy filings, there are eligibility requirements. One is having permission from their state-specific government. Some states allow municipalities to declare bankruptcy independently, while others require specific steps before filing, and some states do not allow Chapter 9 at all.

If the state grants permission for the filing, the municipality files a petition to the federal government to restructure the debt.

Chapter 15

Chapter 15 bankruptcy is the new kid on the block, only enacted into law in 2005, per the U.S. Courts website.

Chapter 15 bankruptcy allows foreign nationals to file for bankruptcy in the U.S. bankruptcy courts if they have assets, property, or business in multiple countries, including the United States.

This type of bankruptcy has five primary objectives:

  • It facilitates cooperation between the courts, parties of interest, and other authorities in multiple foreign countries for international bankruptcy cases.
  • It improves the efficiency of cross-border bankruptcies and includes protecting all parties’ financial concerns.
  • Ensures that the filer’s assets are assessed at their fair and total value
  • Creates legal stability for international businesses
  • It helps companies with their financial struggles

Insolvency vs. Bankruptcy

Insolvency and bankruptcy are not the same. You can be insolvent without being bankrupt, but you can’t be bankrupt without being insolvent.

Insolvency means you’re unable to pay your debts when they are due. There are a few other ways to escape insolvency without filing for bankruptcy. Some of the most common include:

Considering Bankruptcy? Here Are the Next Steps

Sometimes your situation seems so hopeless that bankruptcy looks like your only option. You are scared and backed into a corner, and bankruptcy isn’t a decision to take lightly. Knowing the different types of bankruptcies is essential to make the best decision for your situation.

Bankruptcy can be a difficult time for any individual or business owner. Here are a few tips to consider before determining a bankruptcy plan:

  • Get familiar with each type of bankruptcy chapter to determine the best fit for the filer’s needs.
  • Consult a bankruptcy attorney. Bankruptcy laws are complicated. An experienced attorney will be familiar with the U.S. bankruptcy code and will be able to advise you on your best course of action.
  • Consider the costs. Bankruptcy can be expensive for filers. It may not make financial sense to pay the various fees, depending on your financial situation and your debt.
  • Consider other debt-relief options, including a debt consolidation company or taking a loan from your savings or retirement plan.
  • Call creditors and settle debt amounts, especially for consumer debt like credit cards.
  • Prepare for a massive hit from all three major credit bureaus. And expect the bankruptcy filing to stay on a credit report for several years.

Treat bankruptcy as a last resort. It will affect your financial situation for up to 10 years, depending on which type of filling you choose.

The Bottom Line

The bankruptcy process is serious. You go before a judge and tell them you can’t pay your debts. Depending on the situation, they will erase your debts or develop a plan for you to pay them back. There are several reasons why people file for bankruptcy — things like job loss, a divorce, expensive medical bills, poor financial management, or unexpected emergencies.

Don’t let the final decision scare you. It may feel like Armageddon on your psyche, but bankruptcy can be a fresh start to a new you. Information is power.

Find a reputable bankruptcy professional who has empathy for your situation, understands you are feeling guilt and shame, and that the last thing you need is an advocate who ladles on judgment or condescension.

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